Housing Reform's Investor Bonanza: Street Whispers

Written by: Dan Freed11/21/12 - 7:00 AM EST

Tickers in this article:
OCN FNMA RDN NLY BAC

NEW YORK ( TheStreet) -- Democrats and Republicans appear to agree the U.S. government's multi-trillion dollar support for the U.S. housing market needs to shrink, and there is massive money to made for investors who can correctly handicap the companies that stand to benefit from the shakeout.

"Moving the U.S. residential mortgage industry back into the private sector offers the greatest growth opportunities in U.S. financials over the next ten years," states a report published Tuesday by Keefe Bruyette & Woods.

Such a bold statement would seem to call for a few stock picks, but alas, KBW's report offers not a single one. Still, it has some ideas worth considering.

First, post-crisis housing winners such as Ocwen Financial (OCN) Annaly Capital Management (NLY) and American Capital Agency Corp. (AGNC) , and will have to reinvent themselves if they are going to continue their success of the past few years.

"These firms took advantage of the growth in GSE mortgage production and the spin out of non-prime mortgage servicing. Neither of these trends is likely to continue indefinitely," KBW's report contends.

Ocwen, which services long-delinquent mortgages, has picked up massive market share as troubled companies like Bank of America (BAC) and bankrupt ones like Residential Capital have been eager to rid themselves of difficult servicing responsibilities while raising funds to boost capital levels or pay creditors.

Annaly and American Capital--the giants of the mortgage real estate investment trust space, have paid out double-digit dividends by borrowing cheaply and using leverage to buy mortgage backed securities (MBS) issued by Government Sponsored Enterprises (GSEs) Fannie Mae (FNMA) and Freddie Mac (FMCC) . Since the 2008 crisis, the GSEs have supported the mortgage market as private capital has virtually disappeared.

Private capital will presumably have to come back at some point, and politicians appear determined to shrink the government's role, though whether they will agree on how to accomplish this goal without sinking the U.S. economy remains to be seen.

The task is so perilous that KBW Washington analyst Brian Gardner arguesno first term President would take it on. Thus, the reelection of President Obama--not to mention Congress's urgent need to find expenses to cut to avoid sending the U.S. economy over the dreaded "fiscal cliff"-- has increased the odds of something being done.

Still, the wait may be longer than KBW's report appears to suggest. If it isn't, and President Obama and Congress manage to put a plan in place, KBW offers just a single sentence in the report to suggest how investors might position themselves.

"As the housing market recovers and the government moves to wind down the GSEs, we expect that value growth to shift to non-agency MBS REITs, bank portfolio lending, mortgage insurers, and specialty mortgage service providers," is what that sentence says.